Question

Consider the following variation of Table 11-1 for the U.S. semiconductor market

	U.S. Tariff rates
	0%	8%	16%
From Canada, before NAFTA	$45	$W	$52.2
From Asia, before NAFTA	$40	$X	$Y
From Canada, after NAFTA	$43	$Z	$Z
From Asia, after NAFTA	$40	$X	$Y
From the United States	$46	$46	$46

1. Fill in the values for W, X, Y, and Z.
2. Suppose that before NAFTA, the United States had a 16% tariff on imported semiconductors. Which country supplied the U.S. market? Is it the lowest-cost producer?
3. After NAFTA, who supplies the U.S. market? Has either trade creation or diversion occurred because of NAFTA? Explain.
4. Now suppose that before NAFTA, the United States had an 8% tariff on imported semiconductors. Then repeat parts (b) and (c).
5. In addition to the assumptions made in (d), consider the effect of an increase in high-technology investment in Canada due to NAFTA, allowing Canadian firms to develop better technology. As a result, three years after the initiation of NAFTA, Canadian firms can begin to sell their products to the United States for $40. What happens to the U.S. trade pattern three years after NAFTA? Has either trade creation or diversion occurred because of NAFTA? Explain.

Answer 1

a. W=45+8/100*40 = 45+3.6=$48.6

X=40+8/100*40 = 40+3.2 =$43.2

Y=40+16/100*40 = 40+6.4 =$46.4

Z=43+8/100*43 = 43+3.44 =$46.44

b. Before NAFTA, the tariff on semiconductors in US was 16%. Since, US produced semiconductors at the lowest price ($46) itself, it will not import semiconductors from any country (price of semiconductors in Asia and Canada with 16% tariff were $46.4 and $52.2).

c. After NAFTA, US will not import from any country as its domestic price ($46) is still lower than others. (Price after NAFTA for Asia and Canada are $46.4 and $46.44 respectively). Hence, no trade creation or trade diversion has occurred due to NAFTA at 16% import tariff.

d. If import tariff falls to 8% in US, then before NAFTA, US will import semiconductors from Asia. This is because domestic price of semiconductors in US($46) and Canada($48.6) are higher than that in Asia($43.2).

After NAFTA, US will continue to import semiconductors from Asia($43.2) as the price of semiconductors in Canada($46.44) and US($46) are higher. There is only trade creation in this situation.

e. Due to technological progress after 3 years of NAFTA, US will import semiconductors from Canada at the lowest price of $40. Hence, there is both trade creation and diversion in this situation as trade begins between different countries and due to technological progress import shifts from Asia to Canada.